Most US taxpayers overlook one critical factor, which can quickly turn a manageable tax bill into a financial headache: interest. If you do not pay your federal taxes on time, the IRS will start charging interest immediately, and unlike penalties, interest is rarely waived or reduced.
What is worse, the longer your balance remains unpaid, the faster the amount you owe grows. Let us show you the steps to avoid watching your tax bill balloon out of control.
IRS Interest Rates for Payment Plans
The IRS starts to charge interest on your account the very first day that you are late and have not paid the entire tax debt. Interest is applied to the remaining balance and continues to accrue until the balance is paid off. Even if you set up a payment plan, interest continues to accrue on your account.
Moreover, the IRS interest rate compounds daily, meaning it is assessed to your account daily. Therefore, even small balances can increase significantly over time.
What are the IRS interest rates for 2024?
How are interest rates set? The rate is determined quarterly. According to the IRS announcement on February 21, 2024, interest rates will remain the same for all four quarters. The IRS interest rates for individuals on underpayments and overpayments are set at 8%.
- 8% for overpayments (payments made more than the amount owed), 7% for corporations.
- 5.5% for the portion of a corporate overpayment exceeding $10,000.
- 8% for underpayments (taxes owed but not fully paid).
- 10% for large corporate underpayments.
How Does the IRS Calculate Interest on Unpaid Taxes?
The IRS interest on unpaid taxes is compounded daily, meaning it adds up on both the original tax owed and any previously accrued interest. This continues until the entire balance, including interest, is paid off.
In rare situations, such as if the IRS made a mistake, interest may be reduced or waived. However, interest typically cannot be waived just because you missed a payment.
How Does the IRS Calculate Your Monthly Payment with Interest?
This step-by-step method gives you an idea of what to expect, so you are financially prepared when making monthly payments on your debt.
Step 1: Determine the Base Monthly Payment
Start by calculating your base monthly payment, which is the amount you need to pay to clear your debt in a certain number of months. For example, if you owe $10,000 and plan to pay it off in 60 months (five years), you divide $10,000 by 60. In this case, your base payment would be about $166.67.
Step 2: Calculate the Interest
Say the annual interest rate is 8%. So multiply your balance by the interest rate: 10,000 × 0.08 = $800.
Then, divide this by 12 to get the monthly interest: 800 ÷ 12 = $66.67.
Step 3: Add the Base Payment and Monthly Interest
In our example, 166.67 (base monthly) + 66.67 (interest) = $233.33. This is your estimated monthly payment with interest.
Step 4: Adjust for Penalties (If Any)
If you have a penalty, say 0.25%, add it to the interest rate. In this case, the total rate would be 8.25%. Then, recalculate the annual interest using the new rate: 10,000 × 0.0825 = $825.
Now divide by 12 to get the new monthly interest. 825 ÷ 12 = $68.75.
So, your total monthly payment will be approximately: 166.67 + 68.75 = $235.42.
Important Notes:
- Your interest will decrease over time as you reduce the principal balance.
- This calculation provides an estimate, but it is a useful way to plan for your monthly payments.
IRS Interest Rates and Penalties
The IRS also imposes penalties on unpaid taxes, which can increase the overall amount owed. The late payment penalty, the most common, is typically 0.5% of the unpaid taxes for each month the payment is late, up to a maximum of 25%.
The late filing penalty is more severe. If you fail to file your tax return on time, the penalty is 5% of the unpaid taxes for each month the return is late, up to a maximum of 25%.
If both the late payment and late filing penalties apply, the IRS reduces the late filing penalty by the amount of the late payment penalty to avoid double penalties in the same month.
By resolving tax debts sooner rather than later, you can minimize these extra charges and avoid further financial strain. Otherwise, the penalties continue to accrue until the debt is paid in full or an installment agreement is set up.
How to Avoid Accumulating Too Much Interest
The longer you take to pay off your debt, the more interest accrues, so pay off the debt faster. If possible, make larger or additional payments each month to decrease the principal faster. This strategy will help you lower the total interest paid over time and clear the debt sooner, reducing the overall financial burden.
Moreover, you may benefit from penalty abatement, which reduces or eliminates penalties. However, you should show reasonable cause for why you fall behind on payments. Lastly, if you set up a payment plan, the failure-to-pay penalty drops to 0.25% per month, instead of the higher rate you would face without one. This reduction in penalty helps minimize the overall amount you owe and limits the additional interest that can accumulate.
Lastly
Even if you set up a payment plan, interest will still add up as long as you owe the IRS. However, by making regular payments, you can reduce the amount of interest you pay since you will be lowering the principal balance.
If you are looking for a solution beyond a payment plan or installment agreement for your tax debt, Precision Tax Relief experts are here to help you find the right option. Reach out today for your free initial consultation.
Frequently Asked Questions
Typically, the IRS starts charging interest as soon as taxes become overdue. Even if you request an extension, interest will continue to accrue on any unpaid taxes starting the day after the original filing deadline (usually April 15). Interest will keep accumulating until the balance is paid in full.
Even if you file an extension, interest will continue to accrue on any unpaid taxes during this period.
The interest rates for IRS installment agreements accrue daily until you pay off the tax balance.
The IRS interest rates for unpaid taxes are determined based on the federal short-term interest rate and are updated quarterly. These rates can vary from year to year.
You can request a refund.
There are many tools available online; you can use one of them.
